Posted by Elliot Kravitz, ATP

Loss carry forward and loss carryback: How you can save on taxes

Loss carry forward and loss carryback: How you can save on taxes

Every year does not go as expected, and sometimes it could be a situation where businesses made fewer profits as they did the years before. When the cost of expenses begins to exceed revenue, you will then find yourself in a loss position. It is not always a doom and gloom situation though; this loss can be used to pay off the tax due on profits either in past or future years, this implies that your business can minimize its tax liability. The reason for this is that companies are allowed some tax relief when they are not making much money.

The difference between loss carryback and loss carry forward

Loss carryback allows an individual or business to use a net operating loss (NOL) in one year to pay off a profit in previous years. Carry forward follows the same principle, but the tax loss is carried over to an upcoming year, rather than being used about a year prior.

What is a net operating loss?

A net operating loss is a loss incurred in a period where a company’s permissive tax deductions amount to being more than its taxable income. The company’s NOL can mostly be used to recover past tax payments or used to cut down on future tax payments by making a company unprofitable for tax purposes. Here is an example of putting things into perspective:

Company Y has a taxable income of $1,000,000 and tax deductions of $1,500,000. It implies  its NOL is $1,000,000 - $1,300,000 = -$500,000. Since THE COMPANY has no income to tax, Company Y Will pay no taxes that year.

But what happens if Company Y makes lots of money the next year? If $300,000 of taxable income is made and the company’s tax rate is 40%, then $120,000 would be required to be paid in taxes ($300,000 x 40% = $120,000). The NOL incurred the previous year can be applied to this year’s taxes, which will significantly reduce it, maybe even to zero.

It is also possible for Company Y to carry the NOL back and make use of it for previous years, instead of future years.

The good thing about NOLs is that make relief available to your company if any need arise. If your company is not performing well, the net operating loss is available to show that your business is making no profits for tax purposes.  Some companies are solely purchased only because of their NOLs.

The laws on NOLs vary, depending on your state of residence, but the overall rule is that an NOL from the last few years can be applied up to 20 years period in the future. It expires if not used within this time frame. Every case varies, so the best thing to do is to contact the IRS or get the services of an accountant to ensure you know the right choice for your business.

If a business creates various NOLs in more than one year, the NOLs must be noted in the order they were designed to reduce the risk of one of them not being utilized and then to expire.

Who is qualified to use loss carrybacks and loss carryforwards

Businesses, as well as any taxpayer, can make use of these two provisions against a net operating loss likewise for capital losses over capital gains and particular gains from the exchange or sale of business stock.

Some businesses are purchased for the sole reason they have an NOL. The Internal Revenue Service (IRS) aims at preventing this from happening by restricting the usage of a purchased NOL. Section 382 Limitation typically states that the restriction is in force when there is a minimum of 50% ownership change in the business that has an NOL. The new owner can only use a part of the NOL in each successive year that depends on the long-term.

Means of claiming a loss carry forward or loss carryback

At the best of times taxes can be confusing, so to make it as easy as possible, here are some steps showing how to claim both of these provisions:

Fill out the tax return for your business type

Confirm whether you have a net operating loss. If your tax deductions are more than your income, it could be the situation of you having an NOL. It is not to difficult to calculate following the instructions on Form 1045.

It is when you have to choose  to carry back tax loss to a past year or forward to a future year. If your net loss is above your profit in one year, you can carry over the unused NOL to the next carry forward year or a previous year.

There are, however, several rules for claiming a tax loss carry forward, hence getting the services of a professional is a great idea. 

Elliot Kravitz, ATP
Contact This Member